NON-COMPETITION CLAUSES UNDER CALIFORNIA LAW

IVAN HOFFMAN, B.A., J.D.

California law is very
strict in terms of making sure that parties are not restricted in their
abilities to compete in the marketplace. Unlike some other states,
California has held provisions in agreements that restrict this competition
to be void. In addition, even where trade secrets are potentially
at risk, California has refused to prevent a party from accepting employment
with a competitor simply because there is a claim that disclosure of the
former employer’s trade secrets is “inevitable.” There must be actual
or threatened disclosure. Read “Inevitable
Disclosure of Trade Secrets.”

California Business
and Professions Code section 16600 provides:

Except as provided in this chapter, every contract by
which anyone is restrained from engaging in a lawful profession, trade,
or business of any kind is to that extent void.

A recent California Supreme
Court decision (Edwards v. Arthur Andersen & Company) has again
affirmed this California policy. This is the Court’s summary of the
facts, in part:

In January 1997, Raymond Edwards II (Edwards), a certified
public accountant, was hired as a tax manager by the Los Angeles office
of the accounting firm Arthur Andersen LLP (Andersen). Andersen's employment
offer was made contingent upon Edwards's signing a noncompetition agreement,
which prohibited him from working for or soliciting certain Andersen clients
for limited periods following his termination. The agreement was required
of all managers, and read in relevant part: "If you leave the Firm, for
eighteen months after release or resignation, you agree not to perform
professional services of the type you provided for any client on which
you worked during the eighteen months prior to release or resignation.
This does not prohibit you from accepting employment with a client. [¶]
For twelve months after you leave the Firm, you agree not to solicit (to
perform professional services of the type you provided) any client of the
office(s) to which you were assigned during the eighteen months preceding
release or resignation. [¶] You agree not to solicit away from the
Firm any of its professional personnel for eighteen months after release
or resignation." Edwards signed the agreement.

When Anderson got involved
in the Enron scandal, it sold off parts of its practice and Edwards eventually
was offered employment by HSBC. In the Court’s words:

Before hiring any of Andersen's employees, HSBC required
them to execute a "Termination of Non-compete Agreement" (TONC) in order
to obtain employment with HSBC. Among other things, the TONC required employees
to, inter alia, (1) voluntarily resign from Andersen; (2) release Andersen
from "any and all" claims, including "claims that in any way arise from
or out of, are based upon or relate to Employee's employment by, association
with or compensation from" defendant; (3) continue indefinitely to preserve
confidential information and trade secrets except as otherwise required
by a court or governmental agency; (4) refrain from disparaging Andersen
or its related entities or partners; and (5) cooperate with Andersen in
connection with any investigation of, or litigation against, Andersen.
In exchange, Andersen would agree to accept Edwards's resignation, agree
to Edwards's employment by HSBC, and release Edwards from the 1997 noncompetition
agreement.

HSBC required that Andersen provide it with a completed TONC signed
by every employee on the "Restricted Employees" list before the deal went
through. At least one draft of the Restricted Employees list contained
Edwards's name. Andersen would not release Edwards, or any other employee,
from the noncompetition agreement unless that employee signed the TONC.
{Slip Opn. Page 4}

Edwards signed the HSBC offer letter, but he did not sign the
TONC. fn. 2 In response, Andersen terminated Edwards's employment and withheld
severance benefits. HSBC withdrew its offer of employment to Edwards.

Edwards brought suit.

Edwards alleged that the Andersen noncompetition agreement
violated section 16600, which states "[e]xcept as provided in this chapter,
every contract by which anyone is restrained from engaging in a lawful
profession, trade, or business of any kind is to that extent void." He
further alleged that the TONC's release of "any and all" claims violated
Labor Code sections 2802 and 2804, which make an employee's right to indemnification
from his or her employer nonwaivable.

The Law

In many states, the law
regarding non-compete provisions allows for a balancing of factors.
Such provisions tend to be enforceable if they are “reasonable” in terms
of length of time and geographic area of restriction. The Court reviewed
the common law and the statutory law of California before 1872 and concluded,
as have other California courts:

Today in California, covenants not to compete are void,
subject to several exceptions discussed briefly below.

This court has invalidated an otherwise narrowly tailored
agreement as an improper restraint under section 16600 because it required
a former employee to forfeit his pension rights on commencing work for
a competitor. (Muggill v. Reuben H. Donnelley Corp. (1965) 62 Cal.2d 239,
242-243 (Muggill); Chamberlain v. Augustine (1916) 172 Cal. 285, 289 [invalidating
contract with partial trade restriction].) In Muggill, the court reviewed
an adverse judgment against a company's retired employee whose pension
plan rights were terminated after the former employee commenced work for
a competitor. (Muggill, at p. 240.) The retired employee had sued the former
employer, seeking declaratory relief on the ground that the provision in
the pension plan that terminated the retirement payments because the retiree
went to work for a competitor was "against public policy and unenforceable."
(Ibid.) Muggill held that, with exceptions not applicable here, section
16600 invalidates provisions in employment contracts and retirement pension
plans that prohibit "an employee from working for a competitor after completion
of his employment or imposing a penalty if he does so [citations] unless
they are necessary to protect the employer's trade secrets [citation]."
(Muggill, at p. 242.) fn. 4 In sum, following the Legislature, this court
generally condemns noncompetition agreements. (See, e.g., Armendariz v.
Foundation Health Psychcare Services, Inc. (2000) 24 Cal.4th 83, 123, fn.
12 [such restraints on trade are "illegal"].)

…

We conclude that Andersen's noncompetition agreement was invalid.
As the Court of Appeal observed, "The first challenged clause prohibited
Edwards, for an 18-month period, from performing professional services
of the type he had provided while at Andersen, for any client on whose
account he had worked during 18 months prior to his termination. The second
challenged clause prohibited Edwards, for a year after termination, from
'soliciting,' defined by the agreement as providing professional services
to any client of Andersen's Los Angeles office." The agreement restricted
Edwards from performing work for Andersen's Los Angeles clients and therefore
restricted his ability to practice his accounting profession. (See Thompson
v. Impaxx, Inc. (2003) 113 Cal.App.4th 1425, 1429 [distinguishing "trade
route" and solicitation cases that protect trade secrets or {Slip Opn.
Page 11} confidential proprietary information].) The noncompetition agreement
that Edwards was required to sign before commencing employment with Andersen
was therefore invalid because it restrained his ability to practice his
profession. (See Muggill, supra, "62 Cal.2d at pp. 242-243.)

There was an additional discussion
about the waiver and release agreement but for purposes of this article,
that issue is not relevant. However, any employer seeking to get
an employee, upon termination, to sign a release should absolutely consult
an attorney in California about this proposed document.

Conclusion

If California law applies
to a given transaction, it appears that virtually any form of non-compete
provisions (other than those expressly set forth in the statute) are likely
to be unenforceable. And this likely applies as well even when there
is the possibility, but not actual disclosure of, trade secrets.

This article is not legal advice and is not intended as legal advice.
This article is intended to provide only general, non-specific legal information.
This article is not intended to cover all the issues related to the topic
discussed. The specific facts that apply to your matter may make
the outcome different than would be anticipated by you. This article
is based on United States law. You should consult with an attorney
familiar with the issues and the laws of your country. This article
does not create any attorney client relationship and is not a solicitation.

****************

No portion of this article may be copied, retransmitted, reposted, duplicated
or otherwise used without the express written approval of the author.

FOR MORE INFORMATION INCLUDING IF YOU WOULD LIKE TO BE PLACED ON MY
MAILING LIST TO RECEIVE NOTICES OF NEW ARTICLES AND OTHER RELATED INFORMATION: